As HM Revenue & Customs (HMRC) moves to enforce the Dishonest Agent tax legislation which came into force on 1 April 2013, it stands accused of dishonest behaviour itself.
Earlier this year, HMRC wrote to accountancy practices and tax agents who submit a high volume of Self Assessment (SA) Returns, resulting in a repayment of tax. The High Volume Agents (HVAs), as HMRC refers to them, were invited to voluntarily sign up to a series of principles in a Memorandum of Understanding (MOU), which addressed HMRC’s risk concerns going forward.
The HVAs were told that a follow-up visit would take place to ensure the principles had been adopted and applied, prior to the submission of all 2013 returns filed after the date of the letter.
In the covering letter issued with the MOU, HMRC made plain that:
‘This letter does not constitute any type of formal enquiry or compliance check on you or your clients.’
Further reassurance was provided by the HVAs, when the letter also confirmed that:
‘If you apply all the principals (sic) of the MOU going forward there is no reason to expect any significant outcomes will arise from the (follow-up) meeting.’
However, in practice, HMRC has pursued an entirely different agenda including:
- Insisting that HVAs self amend some of their clients SA Returns prior to the 2012/13 year, applying pre-determined expenses to turnover ratios.
- Threatening to launch enquiries and raise discovery assessments, if the HVAs refuse to comply.
- Risk profiling the HVAs themselves and asking questions about entries on their own SA Returns.
- Questioning the HVAs about their membership of whichever tax faculty they belong to and asking about their minimum accounting standards.
- Raising the prospect of a dishonest conduct charge for failing to meet those minimum accounting standards.
Some HVAs have complied and subsequently lost clients. One accountancy practice is now being sued by some of its clients after amending Returns and giving in t0 HMRC’s pressure.
As part of its Modernising Powers, Deterrents and Safeguards initiative, HMRC has been determined to develop a strategy to enable it to tackle tax agents who act dishonestly in tax matters. It has consulted at length on the subject and has sought to find a way whereby the department can interact with tax agents and deal with dishonest conduct other than by a criminal investigation.
A tax agent is defined in the legislation at Schedule 38 Finance Act 2012 as an individual who, in the course of business, assists other persons with their tax affairs. Individuals can be tax agents even if they work, or the organisation for which they work, are appointed indirectly or at the request of someone other than the client. In other words, it is the individual providing the assistance that is held accountable, rather than the accountancy practice for which they may work.
The legislation can be viewed here
and examples of a tax agent can be found here
HMRC considers dishonest conduct to involve a loss of tax which is ‘illegitimate’ or one not envisaged by tax legislation. The loss of tax may arise from gaining more tax relief than the law allows, or gaining a timing advantage not allowed by law. Dishonest conduct is not negligence or poor quality work by a tax agent.
An overview of HMRC’s operational guidance can be accessed here
There is a penalty for dishonest conduct of between £5,000 and £50,000, but it can only be charged where the dishonest conduct occurred on or after 1 April 2013.
HMRC can publish details of the dishonest conduct, including the name and any trading name of the individual who incurs a penalty. Details of dishonest conduct can be referred to the individual’s professional body and HMRC will also consider registering those individuals, who are not members of a professional body, under the Money Laundering Regulations.
HMRC’s risk concerns
The HVAs have been targeted by the HMRC Local Compliance Fraud teams because their client bases invariably generate repayments, particularly those practices which have a large number of subcontractors suffering Construction Industry Scheme (CIS) tax deductions.
The risk concerns identified by HMRC are:
- The inconsistent application of the statutory wholly and exclusively expense rules.
- Speculative, estimated or round sum non-allowable expenses claimed routinely without any attempt by the agent to test their validity.
- Little and often no assurance work carried out before the submission of the SA Return to HMRC.
- Returns filed with an absence of evidence to support entries in it, or where that evidence was available, ‘insufficiency of checking to validate it.’
Memorandum of Understanding
In order to address these risk concerns, HVAs were asked to sign an MOU which included 8 ‘agreements’:
- A commitment to undertake an awareness programme, designed to remind all clients of their obligations to maintain and preserve adequate business records.
- Assurances would be sought from clients about their business records and some sample testing would take place.
- Clients would be asked to view and approve their completed returns, by signing their acceptance to the submission of their returns in the agreed figures.
- Particular attention would be given to obtaining supporting evidence for business expenses and CIS income and deductions.
- Checks would be conducted to ensure expenditure had been incurred wholly and exclusively.
- No return on behalf of a subcontractor, who has not maintained any business records to evidence levels of expenditure incurred, would be submitted with the expenses to turnover ratio exceeding 10%. (Expenses include capital allowances.)
- A return on behalf of a subcontractor reflecting a turnover ratio in the range of 10% – 20% would be based on kept records, with sample assurance tests conducted.
- Any return on behalf of a subcontractor reflecting an expenses to turnover ratio over 20% would only be submitted if all the records have been seen and are available to support the figures shown on the return.
What has happened in practice?
Based on the cases the Resource Tax and VAT Consultancy team is aware of, HVAs signed the MOUs on the understanding they would tighten their procedures going forward.
They have since adopted a more critical approach to examining the business records given to them by their clients and tested explanations put forward in support of expenditure claims.
However, when HMRC officers have conducted their follow-up visits, they have sought adjustments to years prior to the MOU and invited HVAs to amend their clients’ accounts and returns, to fall in line with the expenses to turnover ratios deemed acceptable by HMRC. If the HVAs have refused, HMRC has threatened to launch enquiries and to undertake more formal interventions going forward.
The HVAs have also found themselves subjected to risk profiling and confronted with questions about their own tax affairs.
I am representing an accountancy practice which has fallen within the scope of this HMRC activity.
The practice involved has around 600 clients, of which 60% are subcontractors. An MOU was signed and the 8 ‘agreements’ applied. The practice took a further step and introduced a new standard Terms of Engagement to make its clients fully aware of what was expected of them.
The 2013 SA Returns which have been submitted so far this year do show a reduced level of expenditure claimed. For example, in the past, the practice may have vouched an expense by checking a deduction from the business bank or credit card statement. Now, the practice does not put through an expense unless the original receipt is available.
Despite implementing stricter controls, the expenses to turnover ratios are still not falling within the average 10%-20% range determined by HMRC. During the first follow-up visit, the HMRC officers reviewed the accountancy link papers relating to 5 subcontractor clients. Based on the review, the practice was then asked to amend circa 200 Returns relating to the 2012 year. This request was accompanied by a carrot and stick approach, the carrot being that the additional tax arising from the amendments would not incur a penalty, but the stick meant that failure to comply with the request would result in enquiries and discovery assessments.
The practice refused to do the amendments on two grounds, namely:
- The practice insisted the Returns it had submitted prior to 2013 were accurate.
- If the amendments requested were implemented, it would inevitably lose clients and put the practice in financial danger.
During the second follow-up visit, the HMRC officers pointed towards the reduced expenditure being claimed on the 2013 SA Returns to date and said that gave the department reason to be concerned the previous returns were incorrect.
It transpired the main risk area centred on the travelling claims put through for the 5 clients in question. A lively debate took place concerning the Horton v Young tax case and the interpretation of itinerant and habitual travel. The HMRC officers were also reminded why some of the claims were outside the average ratio level. One of the subcontractor’s is being charged £3,000 annually for his van insurance because of his age, whilst a new van has been claimed for under the Annual Investment Allowance for one of the other client’s.
Despite travel being the main risk area, the HMRC officers asked to see the full business records for the 5 clients and then began to direct questions to one of the accountants in the practice concerning his own personal tax affairs going back to 2010. The accountant answered the questions because he had nothing to hide.
A third follow-up visit is due to take place in August.
The primary objectives of HMRC cannot be faulted. It wants to reduce the loss of revenue to the Exchequer from excessive and unjustified repayment claims submitted by unscrupulous tax agents. At the same time, it wants to drive wider behavioural change and prevent dishonest conduct, by ensuring minimal accounting standards are met.
The tax agent professional bodies fully support HMRC in taking strong action against the small minority of tax agents who deliberately help others to evade tax.
However, the evidence gleaned so far suggests the MOU was mis-sold to tax agents and the tactics being adopted by HMRC to secure adjustments for earlier years are bordering on intimidatory, especially when it is predominantly small and mid-sized practices that are being caught up in this initiative.
There is no dispute that HMRC needs to tackle fraudulent repayment claims made by HVAs who may, for example, have a fee structure which involves a commission or percentage cut of any pay-out received and a vested interest in securing an excessive amount.
Sometimes though HMRC can be guilty of using a hammer to crack a nut and this initiative is rapidly repeating that past form. Some key questions need to be addressed quickly.
Firstly, HMRC is placing emphasis on tax agents abiding by minimum accounting standards. To a tax agent that generally means providing tax expertise and services carried out with professional competence, in accordance and consistent with the law. However, it can also mean putting forward the best position on behalf of a client based on a full disclosure of facts and information supplied by the client.
There seems to be a disparity here between what is expected in terms of minimum accounting standards from the professional tax bodies and HMRC’s wish to see the tax agent almost act as a policeman, actively challenging expenditure claims and testing explanations provided.
Secondly, does a different interpretation of tax law and of tax cases become grounds for a dishonest conduct charge? During the discussions I had with the HMRC officers concerning allowable business travel and the interaction of Horton v Young, I was told that if the accountancy practice has taken a reasonable and defendable view of the rules to be applied, then dishonest conduct would not be considered. However, if the rules have been interpreted and construed to generate a particular outcome, then HMRC may take a different view.
Thirdly, there is little doubt the original letters and MOU agreements were mis-sold to tax agents. The feedback we have received is that tax agents signed the MOUs on the understanding they would tighten their procedures going forward. They did not expect to be asked to self amend earlier years Returns without their clients approval and to then find themselves subjected to risk profiling and intrusive questions. The approach to this initiative has only served to reignite fears about how HMRC will use and interrogate its Agent View online data when the system becomes fully operational.
Fourth, should tax agents continue to co-operate with this HMRC activity, as they have generally been doing, or should they simply tell HMRC to open formal enquiries?
Finally, how do arbitrary expense to turnover ratios fit with the basic premise of the tax system in that people should pay the right amount of tax at the right time? The ratios do not fulfil that function and, in effect, set a ceiling; the breaching of which will seemingly result in some sort of compliance intervention from HMRC.
The unknown in all of this, is how will subcontractors react when they realise HMRC is applying the ratios? Will they fall into line and keep better records, or will they take an alternate view and start to do unrecorded cash jobs, if their expenditure is going to be restricted or constantly challenged?
( A version of this article was published in Taxation magazine.)
Author: Guy Smith, Senior Tax Consultant on the ReSource Tax and VAT Consultancy Team.